Global equity markets posted gains during the first quarter of 2021 as vaccine progress drove optimism about the reopening of the global economy. But market risk is about more than vaccines and value stocks. Looking at the Intech Equity Market Stress Monitor®, we continue to see signs of potential instability across equity markets that suggest caution in both developed and emerging markets.
Broad indices of large-cap developed equity markets rose by a further 4-5% as optimism around vaccination programs and the reopening of the global economy continued. This sustained rally since the COVID crash of last year means that large-cap developed markets have returned over 55% over the last 12 months.
Looking a little more closely, two key reversals that began in the fourth quarter of 2020 continued in the first quarter of this year. First, we saw a continuation in the resurgence of value stocks relative to growth. This was especially pronounced in the U.S. small-cap space, where the value index rose by 21%, and outperformed growth by more than 16% in this 3-month period.
Second, we saw a continuation of the rebound in small-cap stocks relative to large. Until the fourth quarter of last year, capital had been concentrating in U.S. markets for the previous 5 years, led by the dominance of U.S. mega-cap growth stocks, which strongly outperformed smaller stocks. This had a knock-on effect on the distribution of capital in global benchmarks also, where the U.S. represents around 60% of the capital in developed benchmarks. However, since October of last year, this trend may be showing signs of exhaustion.
This chart from the Intech Equity Market Stress Monitor® shows the level of capital concentration in U.S. and Global stocks in the last two quarters. If the concentration is peaking, it’s worth noting because a reversal of the previous 5-year trend of ever-increasing capital concentration levels portends potential market stress.
It’s also noteworthy that the picture is very different outside the U.S. This chart shows the same measure of capital concentration for the MSCI EAFE, Europe and Australia indices, and you can see immediately that the absolute level of capital concentration is at the opposite end of the spectrum in both cases. And this low level of concentration has actually further decreased in the last 6 months.
In general, Intech Equity Market Stress Monitor® indicators for most global markets suggest a somewhat less-stressed condition than has previously been the case. The one exception to this is the stubbornly high level of stock correlations. These have increased sharply over the last 12 months and remain close to all-time highs. This is indicative of a heightened level of systematic risk in equity markets.
Finally, one trend that has not reversed over the last couple of quarters is the persistently strong returns for the beta factor in both U.S. and global markets.
In such an environment, investors rewarded the highest beta stocks, and this continued to be the case in the first quarter of 2021.
Of course the implications of this for defensive equity strategies, which tend to be underexposed to higher beta stocks, is clear, and such portfolios have typically lagged in recent periods. This can be seen in the difference in return between Minimum Volatility Indexes and their cap-weighted counterparts over the last 12 months.
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